Canada’s Service Sector Contracts Amid High Interest Rates and Weak Demand

Summary

  • In December, business activity increased slightly to 44.6 from 44.5 in November, an almost three-and-a-half-year low. Despite the uptick, it remained significantly below the 50 benchmark which indicates growth in the sector.
  • High interest rates have been identified as significantly impacting Canada’s service sector economy, with reduced demand and activity particularly seen in real estate markets.
  • In response to inflation, the Bank of Canada increased interest rates to a record 22-year high of 5%. The repercussion is seen in the latest housing data where sales fell by 43% in November from the first quarter of 2021.
  • The PMI’s reading of new business dropped to a three-year low in December, while export business saw an even greater contraction. However, a decline in inflation pressure indicated some positive news.
  • Canada Composite PMI Output Index dropped to its lowest in December since June 2020, while Canada’s manufacturing PMI fell steeply in December, showing a sharp contraction in the factory industry since the early wave of the COVID-19 pandemic.

Canada’s Economic Performance

There was a slight increase in the headline business activity index in December, rising to 44.6 up from November’s near three-and-a-half-year record low of 44.5. Nevertheless, the rate sat markedly below the 50 line dividing growth from contraction in the sector.

Impact of High Interest Rates

According to Paul Smith, Economics Director at S&P Global Market Intelligence, the effect of a stringent monetary policy on Canada’s service sector economy was conspicuous in December. The high interest rates significantly contributed to weakened demand and activity, especially in the real estate markets.

Housing Market Decline

In an attempt to moderate inflation, the Bank of Canada has increased interest rates to a record-breaking 22-year high of 5%. This is mirrored in the Canadian housing sector where sales in November were down by 43% from their peak in the first quarter of 2021.

Business and Market Situation

The PMI’s indicator of new business fell in December to a three-year low of 45.3, while new export business also demonstrated an even more significant contraction. However, there were signs of easing inflation with reduced prices charged, making for a positive turn in the data. The S&P Global Canada Composite PMI Output Index, which records manufacturing as well as service sector activity, hit its record low since June 2020, falling to 44.7 from 44.8.

Furthermore, Canada’s manufacturing PMI fell to 45.4 in December depicting the most rapid pace of contraction in the factory sector since the early months of the COVID-19 pandemic, highlighting the economic impact of the virus.

The recent developments in Canada’s economy, especially fluctuations in interest rates and the contraction of manufacturing and service sectors can directly impact forex markets. Currency traders, in particular, might experience shifts in the value of the Canadian Dollar.

PIP Penguin
Logo